Educational Articles

Dogs of the Dow Midyear Review

Mario Ferro
| July 27, 2015

June Swoon Leaves Dog Owners Seeing Red

Although the year has been notable for the major indexes hitting new all-time nominal highs, stocks have had a tough time staying in positive territory. Among the factors making up this year’s "wall of worry" have been low oil prices, debt woes in Greece, and the Federal Reserve’s imminent first step toward monetary tightening. As it pertains to the Dow Jones Industrial Averages, a 2.5% dip in June landed the index 1.3 percentage points in the red for the year to date. Meanwhile, the Dogs of the Dow have largely underperformed, beating their benchmark index in only two out of six months in the first half. June marked a second-consecutive month of losses for the mutts. But, on the whole, they were not trailing by an exceedingly wide margin at the half.

Telecom giant AT&T (T) was the sole gainer among the lot for the month, rising 2.8%. It was also the top performer for the second quarter, with an 8.8% advance. The company has had an active year on the acquisition front, and will likely be significantly transformed by yearend. Notably, AT&T was imminently scheduled to close on its $49 billion acquisition of satellite TV provider DIRECTV (DTV). The purchase will make the company the largest pay TV provider in the U.S. and should catapult it among the larger players in the booming streaming video market. The move will also boost AT&T’s presence in South America, as it picks up over 18 million new customers in that region. The company’s business south of the border was also recently boosted by its $2.5 billion deal for Iusacell, a Mexican wireless carrier, and its $1.9 billion acquisition of Nextel Mexico. Note: Apple (AAPL - Free Apple Stock Report) replaced AT&T in the Dow in March, however, for our purposes, we will continue to track AT&T as part of the original 2015 Dogs of the Dow.

Bad Dogs

Among the notable underperformers for June was Merck (MRK - Free Merck Stock Report), whose shares fell 6.5%. Bottom-line growth at the New Jersey-based drug maker has been kept in check by lower revenues, mostly due to increased generic competition for several of its key products. The sale of its consumer health business to Bayer, and the negative effects of a stronger U.S. dollar, have also weighed on results. However, we look for the negative trend in year-over-year sales comparisons to finally reverse itself in 2016. That, along with improving margins, suggest earnings should pick up significantly.

Meanwhile, shares of Chevron (CVX - Free Chevron Stock Report) dipped 6.3% last month. First-quarter sales and earnings at the world’s fourth-largest oil company came in better than were generally expected, but were still off significantly from the prior-year’s results. Like its industry peers, operations continue to suffer from lower crude oil prices. Moreover, the relatively positive news was offset by weak cash flow in the quarter and the high number of rig stoppages in productive areas. Also, investors were less-than-enthusiastic about the company passing on its traditional second-quarter increase in the dividend payout. Oil prices have arisen from the lows set in March, but a glut of inventory and few catalysts for dramatic jumps in global energy demand suggest 2015 earnings will likely be less than half of last year’s tally.

Also dragging things down were Verizon Communications (VZ - Free Verizon Stock Report), down 5.7%, and Coca-Cola (KO - Free Coca-Cola Stock Report), which fell 4.2%. The former, like its rival AT&T, has also been active on the acquisition front this year, most notably with its $4.5 billion deal to acquire AOL Inc. (AOL). However, that pales in comparison to the aforementioned DIRECTV deal, and likely caused the shares to lose some glimmer in the eyes of investors. Meanwhile, earnings at the venerable beverage maker, Coca-Cola appear likely to come in flat with the prior two years, largely due to foreign currency headwinds taking the fizzle out of growth.

Notable Movers Year-To-Date

Overall, the Dogs shed 1.9% in market value through the first six months. Meanwhile, an equally-weighted position in all 30 Dow components would have slipped by 1.3%, while the 20 issues excluded from the Dogs were down 1.1%.

Shares of biopharmaceutical giant Pfizer (PFE - Free Pfizer Stock Report) held on to the top spot for a fifth consecutive month, with a cumulative gain of 7.6% through June. Like its rival Merck, the company is also being assailed by generic erosion on a few of its aging blockbusters. But its planned $17 billion acquisition of Hospira (HSP), which is due to close by yearend, would provide a nice platform for future growth and another revenue stream to offset patent losses. Management expects the addition to add about a dime to share net in 2016.

Rounding out the top three we have the aforementioned AT&T, which was up 5.7% in the first half, and General Electric (GE - Free GE Stock Report), up 5.1%. The latter is moving ahead with the divestiture of most of its financial services division, GE Capital. The planned return to the company’s industrial roots has likely played a key role in its stock hitting its highest levels in seven years.

Bringing up the rear we have Chevron, down 14.0% and Exxon Mobil (XOM - Free Exxon Stock Report) which fell 10.0%. As mentioned earlier, all companies involved in the production of petroleum have been hit hard by lower prices this year. Unlike Chevron, Exxon (which had a conservative payout ratio) increased its quarterly dividend by 5.8% for the June quarter. Other shareholder friendly moves include a targeted $2 billion in stock repurchases through midyear.

Meanwhile, shares of Caterpillar (CAT - Free Caterpillar Stock Report), the world’s largest maker of earthmoving equipment, were down 7.3% for the period. Asia/Pacific, which had been a source of growth in recent years, has turned into a sore spot for the company, as that region’s economic growth has slowed. Generally lower mining demand is also likely to remain a headwind. Faring only slightly better was Coca-Cola, whose stock shed 7.1% in market value since the start of the year.

Staying The Course

Altogether, when factoring in the Dogs’ yield advantage at the start of the year, performance has largely been on par with the Dow Industrials through the first half. Our general take on equities remains that valuations are somewhat on the high side, but with a dearth of investment alternatives, dividend-paying blue chips, such as those emphasized by the Dogs of the Dow strategy, remain an attractive option.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.